Morgan Stanley should not boost bond trading: analyst

By Lauren Tara LaCapra

Published November 06, 2012

Reuters

Morgan Stanley is aiming to win market share in bond trading, but it is not big enough to compete against rivals like Goldman Sachs Group Inc , and should instead focus on shrinking that business, JPMorgan analyst Kian Abouhossein analyst said.

Even as Morgan Stanley tries to win market share, it has announced plans to reduce the trading assets on its books by $100 billion, adjusting for risk, mainly in fixed income. But Morgan Stanley should scrap its market-share ambitions and pull back further from the bond-trading business, cutting staff and compensation to reduce costs, Abouhossein said.

Other banks are cutting back in fixed-income, including UBS , which said last week it was laying off 10,000 employees, many in bond sales and trading.

Morgan Stanley wants to focus on simpler products like U.S. Treasury bonds and interest-rate swaps, which offer low profits per trade, but can generate high volumes of trades. It hopes to win enough market share in these businesses to boost its overall market share in trading.

"If you're a FICC Fixed Income, Currency and Commodities)player which only makes $6 billion of annual revenue ��� which Morgan Stanley, Credit Suisse and UBS are ��� and you try to run an institutional business, you will struggle against the top six players which make more than $10-14 billion in revenue because you don't have the scale to compete," he said.

A Credit Suisse spokesman declined to comment.

For more than three years, Morgan Stanley has been trying to increase market share in the FICC trading business by 2 percentage points from a previous level of 6.0 percent.

But progress has been hampered by factors including market concerns about Morgan Stanley's exposure to European banks last year and a bond-rating downgrade in June that sent clients to competitors.

Morgan Stanley was able to regain some of that business in the third quarter, and its fixed-income trading revenues rose 89 percent from the prior period, excluding one-time accounting adjustments. Chief Financial Officer Ruth Porat confirmed last month that the bank is still trying to achieve its market share goals.

At an internal firmwide meeting in July, James Gorman told employees that fixed income trading was "a critical business" and an attractive one for the bank, a source who heard his comments said.

Abouhossein said he does not think Morgan Stanley will have to cut back the way UBS did. The Swiss bank faces higher capital requirements than U.S. and European rivals.

SWITCHING GEARS

Morgan Stanley shareholders have watched the bank make big changes to its fixed-income trading business at least four times over the last several years.

First, under former Chief Executive John Mack, Morgan Stanley ramped up its bond trading in the years before the financial crisis, taking big bets with its own money. The move proved ill-timed, and the bank suffered billions of dollars of losses. It pulled back from the business.

When the bond markets rallied in 2009, Morgan Stanley was left unprepared. In July of that year, the bank looked to catch up with competitors by hiring Jack DiMaio, a hedge fund manager with a background in bond trading. But within 18 months, DiMaio was replaced by former Chief Risk Officer Ken deRegt, as current Chief Executive James Gorman put in place his own leadership team and strategy.

Abouhossein, who rates Morgan Stanley shares "outperform," says the bank can get to an 11.7 return-on-equity, compared with 3.9 percent last year, by pulling back from bond trading in the manner he advocates. The measure reflects how much profit a bank can wring from its balance sheet.

"Morgan Stanley has already given guidance, in the second quarter, of reducing RWAs quite aggressively in fixed income," he said. "They have been taking the right steps, but they need to do more."